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August 3, 2016

The following note was recently sent out to the subscribers. I hope you will find it useful.A few of you
may have noticed the frenzy around the NBFC and especially the MFI (micro
finance institutions) space. The buying frenzy is not entirely irrational.

The Indian
household debt at around 9-10% of GDP is among the lowest in the world and
there is a huge pent up demand in the retail / MSME segment. The introduction
of adhaar, regulatory changes and several new technology tools is now allowing
the NBFC segment to reach new customers at a much lower cost and achieve rapid
growth.

We are now
seeing growth in excess of 40% in this space. This is further aided by the fact
that PSU banks and to a certain extent some private sector banks, are not
capable or interested in serving these customers.

So we have a confluence
of factors coming into play here – A new regulatory and technology platform
which allows companies to reach out to a large set of under-served customers at
a time when the dominant players in the ecosystem, namely banks, are not in a
position to take advantage of these opportunities.

We are seeing
this playout in the entire financial services space – Home loans, NBFC, Auto
finance and even structured finance. This is likely to continue for the next
2-3 years.

Tread with
caution

There is
however a dark side to this whole opportunity – A growth of 30%+ may lead to
poor lending practices and weak credit underwriting in several cases. This may
be truer in the case of newer institutions which lack the experience and
management bandwidth to manage this growth (and later collect the bad debts).

We may not see
the impact of these practices for the next 2-3 years, but if poor decisions are
being made, the chickens will eventually come home to roost. We have seen that
in the past in the sub-prime mortgage crisis in the US and the bad debt
problems of the PSU banks now.

The time to be
cautious is now and not when poor lending practices lead to a blow up in
the future. In other words – tread with
caution and be sure what you are buying.

What are we
doing ?

We are already
around 20% of our model portfolio in financials via four companies. These
companies operate in different segments of the financial ecosystem and I
believe that the management of each of these companies is competent and has
seen multiple cycles in their respective businesses. At the same time, if the
frenzy continues and our concentration in this business segment continues to
grow, I will start reducing the position size.

For now, we are
not there yet and hence I am not taking any action.

----------------Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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Disclaimer

I do not provide investment advisory service via this Blog. The stocks discussed on the blog and each post are for educational and discussion purposes only and are not recommendations to buy or sell stocks.I may or may not have a position in the stocks discussed on this blog. For any investment decision, please contact a certified investment advisor.